For those who frequently travel to Japan, the recent years have been financially beneficial due to the weak Japanese Yen. This weakened currency state has increased the spending power of tourists in Japan, including those of us from Singapore.
However, the value of the Yen is not just a matter of concern for tourists; it plays a significant role in Japan’s overall economy. As one of the major global currencies, the Yen’s strength (or weakness) significantly influences Japan’s economic health.
The value of the Japanese Yen is largely determined by the interest rates that are set by Japan’s central bank, the Bank of Japan (BoJ).
Presently, the Japanese Yen is trading at approximately 144 Yen to 1 US Dollar (or about 110 Yen to 1 Singapore Dollar), which is near its historical lowest level. This weak position of the Yen is primarily due to Japan’s current benchmark interest rate, which is actually negative at -0.1%.
What Negative Interest Rates Imply
The concept of negative interest rates was first introduced by the BoJ in 2016. As you would think, these negative interest rates are quite uncommon and indicate that the central bank charges commercial banks for holding reserves, rather than paying them interest.
This policy aims to encourage banks to lend more, thereby stimulating economic growth and fighting deflation. However, it also reflects the challenges that Japan’s economy faces, such as slow growth and low inflation. Put simply, people in Japan would rather save, than invest or spend.
Looking ahead to 2024, there are indications that Japan’s historically low interest rates might undergo changes. This potential shift is significant because any change in Japan’s interest rates can have substantial impacts on its economy and the value of the Yen.
An increase in interest rates, for example, might strengthen the Yen and alter the spending power of tourists, but it could also affect Japan’s economic growth and its export-driven economy. Therefore, any adjustments to the interest rate by the Bank of Japan will be closely watched by economists, investors, and tourists alike.
Deflation In Consumer Prices And Wages
The main reason why Japan has negative rates has been persistently falling prices, otherwise known as “deflation”.
This issue has been a longstanding challenge for Japan’s economy, dating back to the collapse of its substantial real estate and stock market bubbles in 1989. Deflation has a profound impact on consumer behaviour and the overall economy.
In the summer of 2016, a key indicator of this deflationary trend was evident when Japan’s consumer price index (CPI) fell by 0.5%. This decline in CPI was a critical factor that led the BoJ to adopt negative interest rates. The logic behind negative rates is to encourage spending and investment in an economy where falling prices lead consumers to delay purchases. The anticipation that prices will be lower in the future discourages immediate spending, thus creating a vicious cycle that further suppresses economic activity.
Moreover, this deflationary trend extends beyond consumer prices and affects the workforce and wage structures in Japan. In contrast to the inflationary wage-price spiral concerns in the United States in 2023 – where rising inflation was leading to higher wages, which in turn fueled further inflation – Japan faced the opposite scenario. With low inflation or deflation, there is little to no pressure on companies to increase wages. As a result, many large Japanese corporations have offered only minimal, if any, increases in base wages, reflecting the overall trend of falling prices.
However, as 2024 begins, there are signs that the economic landscape in Japan is changing. These changes could prompt the BoJ to reconsider its stance on interest rates. If the deflationary pressures begin to ease and the economy shows signs of improvement, there may be justification for the BoJ to increase interest rates. Such a move would be aimed at normalizing monetary policy and preventing any potential future economic imbalances. However, any decision to change interest rates would be made with caution, considering the delicate balance of fostering economic growth while preventing a return to deflation.
Multi-Decade Highs In Inflation For Japan
The likelihood of the BoJ raising interest rates into positive territory in 2024 is significantly influenced by the resurgence of inflation in the Japanese economy. This development marks a notable shift from Japan’s prolonged struggle with deflation, particularly in the context of the global economic landscape following the COVID-19 pandemic.
During the pandemic, while many countries grappled with high inflation rates, there was skepticism about whether Japan would experience a similar trend, given its historical battle with deflation. However, inflation has returned, thankfully, to the Japanese economy. At the beginning of 2023, inflation in Japan hit 4% for the first time in four decades. That inflationary trend persisted throughout 2023 and Japan’s “core core” CPI – which strips out food and energy prices – rose 3.6% year-on-year in November 2023.
Although this was a slight decrease from the previous month’s figure, the sustained period of elevated inflation levels provides the BoJ with a potential rationale for increasing interest rates.
Another significant factor supporting the possibility of an interest rate hike is the wage growth observed in Japan’s labour force. This wage growth is not just a transient phenomenon but rather suggests a more enduring change in the economy. In 2023, large companies in Japan agreed to wage hikes averaging 3.6%. The focus now shifts to the annual “shunto” wage negotiations, which take place early in the year between labour unions and management. These negotiations are closely watched as they set the tone for wage trends across the country.
If these negotiations result in wage increases that exceed the 3.6% rate seen in 2023, it would provide further evidence of sustained inflationary pressures in the Japanese economy. Such an outcome would be a critical factor for the BoJ when considering an interest rate hike. An increase in wages, combined with persistent inflation, indicates a more robust and stable economic environment, which could justify a shift towards positive interest rates to maintain economic balance and prevent overheating.
Japan Is Back In Investors’ Good Books
The performance of Japan’s stock market has been a subject of disappointment for investors since the burst of the bubble in 1989. However, a significant turnaround occurred last year when the country’s benchmark Topix Index finally exceeded its 1989 peak, setting a new record high. This milestone reflects a changing sentiment and renewed optimism among investors regarding Japan’s economic prospects.
A key driver of this optimism is the return of inflation in Japan. For years, Japan’s struggle with deflation has been a major concern, dampening economic growth and investor confidence. The resurgence of inflation is seen as a positive sign, suggesting a healthier economy. Inflation indicates increased consumer spending and economic activity, which can drive corporate profits and, by extension, stock market performance.
Additionally, Japan’s economy is benefiting from solid performance and favourable geopolitical circumstances. One such circumstance is the global trend of diversifying supply chains and reducing reliance on China. This shift has presented Japan with new opportunities for economic growth and investment, as companies and countries seek more diversified and stable trade partnerships.
Overall, these factors – the return of inflation, the possibility of a positive shift in interest rates, strong economic performance, and beneficial geopolitical trends – contribute to a more optimistic outlook for Japan’s economy and stock market. Investors are closely watching these developments, anticipating that these positive changes may sustain and enhance Japan’s economic and market performance in the near future.
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